How stock exchanges are experimenting with blockchain technology

Prableen Bajpai , 15 Jun 2017 - ExchangeFinanceOpinion

Prableen Bajpai is the Founding Director at FinFix; an enterprise in India, primarily engaged in financial research, reports, training and spreading financial literacy while striving to provide counselling to the economically less privileged.

Blockchain has been called the future of financial services infrastructure. While banks were among the first to hop aboard the blockchain bandwagon, stock exchanges have been quick to keep pace. Here’s how some of the most prominent stock exchanges in the world are working to leverage the distributed ledger technology in order to fundamentally overhaul traditional mechanisms.

- Ginni Rometty, IBM CEO

Blockchain has ignited curiosity among industries and sectors, especially in finance, and has been called “the future of financial services infrastructure.” While banks were among the first to hop aboard the blockchain bandwagon, stock exchanges—an integral part of capital markets—are quick to keep pace.

Today, some of the most prominent stock exchanges are looking at ways to leverage the distributed ledger technology (DLT) in order to fundamentally overhaul traditional mechanisms.

The functioning of stock exchanges involves complex procedures that can be time consuming, cost inefficient, cumbersome, and prone to risks. The multi-layered processes—pre-trade, trade, post-trade and custody, and securities servicing—are extraordinarily complex. This makes a case for experimentation with blockchain, thanks to its potential ability to streamline the process.

A report by Oliver Wyman suggests, “IT and operations expenditure in capital markets is currently close to $100-150 billion per year among banks. On top of that, post-trade and securities servicing fees are in the region of $100 billion. Significant capital and liquidity costs are also incurred because of current delays and inefficiencies within market operations.”

The distributed ledger technology could enable savings for the entities involved by reducing duplication of processes, settlement time, collateral requirements and operational overheads. This, in turn, would minimize the need to set aside financial resources to cater to counterparty risks and achieve higher anti-money laundering standards and reduced risk exposure.

Here's a look at what some of the exchanges are doing:

Nasdaq has been at the forefront of the blockchain revolution. At the turn of 2015, Nasdaq unveiled the use of its Nasdaq Linq blockchain ledger technology to successfully complete and record private securities transactions for—the inaugural Nasdaq Linq client. In May, Nasdaq and Citi announced an integrated payment solution using a distributed ledger to record and transmit payment instructions based on Chain’s blockchain technology. The technology overcomes challenges of liquidity in private securities by streamlining payment transactions between multiple parties.

Australian Stock Exchange (ASX) began to evaluate replacement options for the Clearing House Electronic Subregister System (CHESS) in 2015. Eventually, ASX selected U.S.-based blockchain startup Digital Asset Holdings, LLC, to develop distributed ledger-based solutions for clearing and settling trades. It made an investment of $14.9 million to acquire a 5% equity interest in Digital Asset, which was later raised to 8.5% through an additional investment. ASX’s project timeline mentions end-2017 as the key decision point to implement DLT or alternative technology to replacing CHESS.

Japan Exchange Group (JPX) and International Business Machines Corporation (IBM) are working toward testing the potential of blockchain technology for use in trading in low transaction markets.

Korea Exchange has launched Korea Startup Market (KSM) with Blocko’s blockchain technology to enable equity shares of startup companies to be traded in the open market. In December, a consortium was formed with leading financial investment and blockchain tech companies to “function as a leading blockchain think tank in the local capital market.” A full-scale pilot project on blockchain-powered financial services is planned in 2017.

In Germany, Deutsche Börse and Deutsche Bundesbank presented a functional prototype for the blockchain technology-based settlement of securities in November 2016. Further development over the next few months is expected to help them “analyze the technical performance and the scalability of this kind of blockchain-based application.” Frankfurt-headquartered Deutsche Börse Group is one of the largest exchange organizations worldwide.

In early 2017, India’s National Stock Exchange (NSE)conducted a blockchain trial involving the country’s leading banks—IDFC, Kotak Mahindra, ICICI, IndusInd and RBL, as well as HDFC Securities. The blockchain trial related to know-your-customer (KYC) data was enabled by a blockchain start-up Elemential. NSE is the leading stock exchange in India and the fourth largest in the world by equity trading volume (World Federation of Exchanges, 2015).

Meanwhile, Moscow Exchange (MOEX) successfully conducted e-voting for bondholders via blockchain at the National Settlement Depository (NSD). The pilot version is expected to be launched in 2017. MOEX was the first Russian financial institution to join the Hyperledger Project in mid-2016.

The London Stock Exchange, part of the PDTL Group, is involved in ways to improve the post-trade space using the blockchain technology. Meanwhile, the Luxembourg Stock Exchange has already introduced a blockchain-enabled security system wherein the officially generated signature by appointed mechanism (OAM), along with document type and document URL, are stored in the blockchain.

Santiago Exchange is among the latest stock exchanges exploring the blockchain technology to be applied across Chile’s financial sector. Built by IBM and Chile’s Santiago Exchange, “the solution is designed to help reduce errors, possible fraud, and processing time for each transaction, while also improving transaction management and lowering costs.”

Toronto-headquartered TMX Group recently announced the development of a blockchain-based prototype to power a new service offering from Natural Gas Exchange (NGX). As per the press release, “The NGX use case for the prototype also has the potential to enhance delivery and payment processing, mitigate the risk of, and expedite remediation of, supply shortfalls, and provide secure transactional data.”

Final Word

The potential to enable stock exchanges to significantly reduce the cost and complexity, and increase the speed of trading and settlement processes in a secure manner, has the biggest names in the industry exploring blockchain technology. The path to its adoption will require resolving issues such as scalability, common standards, regulation, and legislation. However, despite the hurdles that lie ahead, it is widely believed that DLT could revolutionize the core infrastructure systems of capital markets around the globe, thereby bringing in greater transparency and efficiency.